Will Someone Shut Alan Greenspan Up?

Jeremy Warner Daily Telegraph August 3, 2010

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Jeremy Warner Published: 8:07PM BST 02 Aug 2010

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Previous of Images Next Greenspan is not treated as the oracle -a status he was given while leading the Federal Reserve. Photo: Bloomberg News Hank Paulson, the former chief executive of Goldman Sachs, and Alan Greenspan, the former chairman of the Fed, on 'Meet the Press'

Having puffed up the credit markets to the point where they were bound to go pop, the former Federal Reserve chairman has since taken his place on the drawing room wall as an antique barometer of the economic weather – much watched but somewhat unreliable. Right now his reading is for rain and more rain.

I'm not saying he's wrong, but a quick Google of Mr Greenspan's forecasting record strongly suggests there is a fault as deep now in his atmospheric readings as for much of the time he was running the Fed.

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Even Michael Fish (a UK weather forecaster who famously told us there was no hurricane in the offing just hours before the Great Storm of 1987) gets it more right than the former Fed boss.

Mr Greenspan's warnings over the weekend that the US economy may be heading for a double dip smacks not just of clambering aboard the bandwagon – he's somewhat late in his observations - but comes just four months after he cheerfully announced that the odds of a double dip "have fallen very significantly" as a result of a shortage of inventories, which he insisted would produce a "self reinforcing cycle".

Now he says we are in a pause in a modest recovery, "but a pause in a modest recover

Jeremy Warner Published: 8:07PM BST 02 Aug 2010

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Even Michael Fish (a UK weather forecaster who famously told us there was no hurricane in the offing just hours before the Great Storm of 1987) gets it more right than the former Fed boss.

Now he says we are in a pause in a modest recovery, "but a pause in a modest recovery feels like a quasi-recession". I shouldn't mock, for my own forecasting record is if anything even worse, but in March 2007, Mr Greenspan said there was only a one third chance of a recession, only to raise this to a greater than 50pc chance in May 2008.

Starting to get it right, then? Unfortunately he then spoilt this rare insight into the blindingly obvious by saying that prospects of a severe recession had receded markedly. As we know, the worst recession since the Great Depression followed soon afterwards.

In November 2006 he referred to the economic slowdown as "likely temporary", and in June 2007 he said that China was a bubble and that a "dramatic contraction is coming". For all his wisdom and experience, Mr Greenspan doesn't seem to have learned the first lesson of forecasting – it's a mug's game.

Central bankers are required to take a view, but in fact they might do better simply to react to the world as it is than as they think it will become. Paying more attention to the present while he was at the Fed might have alerted Mr Greenspan to out of control credit and the need to reign it in. Throughout much of his time at the Fed he did the reverse.

Mr Greenspan's all absorbing mission since then has been to defend his legacy, and to the extent that he admits to getting it wrong at all, to insist this was all a perfectly sensible approach to policy at the time.

He's not alone. Most central bankers will still claim that accommodative monetary policy played little if any part in causing the crisis, or alternatively that they had no option but to adopt such a stance, for to do otherwise would have induced a recession.

Both Ben Bernanke, the present Fed chairman, and Mervyn King, Governor of the Bank of England, argue that it was widening trade imbalances and associated capital flows which were the root cause.

A recent paper by the International Monetary Fund, "Central Banking Lessons from the Crisis", is ambiguous in its conclusions. Citing recent research, it finds only limited evidence that overly accommodative interest rate policy fuelled the bubble in individual countries, but stronger evidence that the global climate of loose money did have a significant effect. In other words, this was not just about failures in banking supervision. Central bankers were part of the mischief.

Next week marks the third anniversary of the start of the credit crunch. Aside from Mr Greenspan's propensity to get it wrong, what have we learnt from the dramatic events of the last three years?

The fashionable view is nothing at all. The banks generally survived – witness renewed buoyancy in profits announced by HSBC yesterday - and with some success, are now busy neutering the reform agenda. Trade imbalances are almost as bad as they were at the peak three years ago, and far from trying to reign in credit, policy is hell bent on re-stimulating it.

All these things are in part true and no doubt entirely reprehensible. Only last week, I wrote at length about the absence of progress in correcting trade imbalances. There is meanwhile a sense in which the bankers have "got away with it" and are already back to their old tricks. Yet the reality is that this absence of change is part of the price that has to be paid for avoiding a depression.

If banks hadn't been rescued, there would have been a perhaps more satisfying process of Darwinian liquidation in finance, but it would also have destroyed savings and jobs on a profoundly more destabilising scale.

As it happens, quite a bit of the old banking system has indeed disappeared, and, to the chagrin of the policymakers who seem to want to return to the let-rip lending practices of the past, there have been significant behavioural changes in credit provision and trading practices.

In many cases there has also been a complete clearout of top management. Liquidity pools have been expanded and leverage reduced. Debt aversion may not be good for demand, but it is surely more healthy in the long term than the credit fuelled consumption of the last decade.

To impose stringent new capital controls on the banks now while balance sheets remain impaired would only further damage credit to the economy. It is right that there should be a prolonged transition period. The presiding policy objective should be to tighten in the boom and loosen in the bust. Central banks have learned that lesson at least.

The long-term reform agenda is certainly being compromised by national differences, populist irrelevance, divide and rule lobbying and excessive complexity, but let's see where we end up before declaring that the bankers have won.

As for the economy, the chances of a significant double dip, in the US at least, have risen in recent weeks, and we know that return to full employment is going to be long and hard. On the other hand, growth is much better than anyone anticipated a year ago.

No change? In fact an awful lot has changed, though it may take time to become fully apparent. Perhaps regrettably, there is one thing that can be relied on to provide continuity in an uncertain world - Mr Greenspan's guesswork.

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